3.1: Production Function and Costs (copy)

Production

Production

Converting inputs into outputs to earn profit.

Input (Factor)

A resource used to make output, typically workers in examples.

Total Physical Product (TP)

Total output or quantity produced.

Marginal Product (MP)

Additional output generated by additional inputs (workers).

Average Product (AP)

Output per unit of input.

Fixed Resource

A resource that doesn’t change with the quantity produced (e.g., tables, scissors).

Variable Resource

A resource that changes with the quantity produced (e.g., workers, papers).

Law of Diminishing Marginal Returns

Additional output from each additional worker will eventually fall as variable resources are added to fixed resources.

Increasing Marginal Returns

Stage where additional inputs lead to increasing output.

Decreasing Marginal Returns

Stage where additional inputs lead to decreasing output.

Negative Marginal Returns

Stage where additional inputs lead to negative output.

Short-run

Period in which at least one resource is fixed; capacity/size is not changeable.

Long-run

Period in which all resources are variable; capacity/size is changeable.

Total Costs

The sum of fixed and variable costs.

Fixed Costs (FC)

Costs for fixed resources that don’t change with production amount (e.g., rent).

Variable Costs (VC)

Costs for variable resources that change with production amount (e.g., raw materials).

Average Fixed Cost (AFC)

Fixed cost per unit of output.

Average Variable Cost (AVC)

Variable cost per unit of output.

Average Total Cost (ATC)

Total cost per unit of output.

Marginal Cost (MC)

Additional cost of producing one more unit of output.

Returns to Scale

Describes how output changes as inputs change.

Increasing Returns to Scale

Output more than doubles as inputs increase.

Constant Returns to Scale

Output exactly doubles as inputs increase.

Decreasing Returns to Scale

Output less than doubles as inputs increase.

Economies of Scale

Firms that produce more can lower average costs through mass production techniques.

Diseconomies of Scale

Long-run average costs increase as the firm becomes too large and difficult to manage.

Big Idea

The law of diminishing marginal returns doesn’t apply in the long run due to the absence of fixed resources.